What is an Employee Stock Ownership Plan (ESOP)?
An ESOP is a Tax “Qualified”, Defined Contribution Plan, governed by the Internal Revenue Service and Department of Labor that was put into law under the Employee Retirement Income Security Act (ERISA) of 1974. More specific an Employee Stock Ownership Plan (ESOP) is:
A plan that offers shareholder liquidity.
A plan that offers succession planning.
A plan that offers financial and equity incentives to employees using tax-deductible dollars from the Company.
A plan that enables a Company to reduce or eliminate corporate taxes.
A plan designed by law to invest primarily in the stock of the sponsoring company.
A plan that is “qualified” by the IRS, which means the company and selling shareholder receive tax benefits not available to other NON ESOP companies or selling shareholders.
A plan that is able to increase working cash flow or restructure debt (dilution).
Why an ESOP?
An ESOP allows shareholders to monetize their equity as part of a succession plan in a tax efficient manner – no other retirement plan can deduct the principal portion of a stock buyout. While monetizing their equity, owners create a perpetual Company where continuing and new employees will be able to share in the equity growth of the Company. An ESOP is one tool but other shareholder exit strategies include:
Sale to Third Party
Sale to Management
Roll up / Private Equity
Initial Public Offering
Wind-Up Business and Liquidate
No plan - Die with a lot of life insurance
Company Benefits:
Income tax savings of 40% to 100%
Able to increase cash flows (dilution)
Corporation can succeed through multiple generations
Able to use pre-tax dollars to repay debt associated with ESOP
S Corporation stock owned by an ESOP is not subject to federal tax
Tax-deductible C Corporation dividends
Shareholder Benefits:
Able to monetize equity and create liquidity for ownership
Value received for stock is at fair market value (must be independent value)
Able to retain control of Company
As a C Corp, able to rollover sale proceeds, tax deferred (1042)
Advantages for Employees:
Employees participate in ESOP as a retirement plan, sharing in equity growth of the Company
Accounts are tax free until a distributable event
Incentivizes/Retains employees beyond a paycheck
ESOP contributions are made solely by the Company
ESOP contributions are typically larger than other retirement plan contributions
Typical ESOP set ups:
Cash fund for (x) years to build up down payment or “war chest” for future sale
Corporation obtains bank loan to purchase stock from owner(s)
Owner carries note
Any combination of above
Myths & Misconceptions:
Owner must disclose all financial information to employees = FALSE
Owner will lose control of Company if ESOP owns more than 50% = FALSE
Owner must sell stock immediately upon plan creation = FALSE
ESOPs are only for large companies = FALSE
ESOP Facts:
Approximately 6,000 ESOPs in U.S.
4,500 majority owned by the ESOP
3,000 are 100% owned by the ESOP
An overwhelming majority of ESOP companies have other retirement and/or savings plans, such as defined benefit pension plans or 401(k) plans, to supplement their ESOP
Found in all industries, not limited to a particular type of business
71% of ESOP’s are in companies with fewer than 250 employees
At least 75% of ESOP’s are or were leveraged, i.e. they used borrowed funds to acquire stock bought by the ESOP from a bank or owner carried paper
ESOPs can be as small as 25 employees, no limit as to how large
Typical Installation of an ESOP
1. Education and information A. Preliminary Meeting(s):
1. Review Company/Board and Shareholder objectives 2. Discuss valuation procedures in ESOP context 3. Discuss ESOP “culture” and sale scenarios
a. corporate governance b. ESOP trustee(s)
4. Go over ESOP rules and long term planning
a. contributions, forfeitures, distributions, leveraging b. on-going record keeping and valuation
c. distribution obligations in future d. impact of employees on value B. Secondary Meeting(s) – as necessary
1. Review first meeting
2. Meet with other Company advisors to address questions/concerns
2. Installation
A. Independent Appraisal of Company for Transaction
B. Take Plan Specs / Draft Plan Document / Draft Transaction Documents C. Review Plan / Transaction Documents, Sign, Submit to IRS
D. Communicate to Employees
E. Typically takes 3-6 months to install the ESOP
F. Installation fees range from $30,000 - $100,000+ depending on complexity
**Steps may be completed in different order**
owners / advisors to understand and analyze their succession objectives. The approach is simple; educate the shareholders & board of directors so that they can make an informed decision on whether or not an ESOP is right for them. With Trivium Analytics educating shareholders and board members, an ESOP can be properly designed to best meet their objectives.
Trivium Analytics has worked with and continues to work with many privately held businesses throughout the United States. We are quite confident our clients will recommend our work and are happy to provide customer references. Thank you for considering Trivium Analytics for your ESOP installation needs.
Contact:
Todd Henry President
Trivium Analytics, Inc. 4713 1st Street, Suite 255
Pleasanton, CA 94566 Phone: 925-523-3398
Fax: 925-369-0496 thenry@triviumanalytics.com
